Everyone says how tough this week’s budget will be, how enormous the budget deficit is and how few options chancellor Alistair Darling has. Which is all true, but only within the tenets of conventional thinking. For a government with vision, this should be a golden opportunity for a landmark budget that seizes the high economic ground. It could change the dynamics of Britain’s finance-driven capitalism and try to constrain unemployment growth while preparing for the upturn that will eventually come. But don’t hold your breath.

For this recession is palpably the result of the collapse of what was, in effect, a gigantic pyramid debt selling scheme. The City’s rise was feted by politicians across the political spectrum, none more than Gordon Brown, confusing Ponzi finance as innovation and creativity. Now the British government has had to put an astounding £1.3 trillion in various guarantees and investments behind the banking system in order to avoid the consequence of its fall. It creates a once-in-a-generation political opportunity to challenge the terms on which Britain approaches both the structures of capitalism and its management. Let’s at least get something back from the highest-ever peacetime budget deficit.

The desire to stick to orthodoxy, though, is very strong, even if it has ended in disaster. What is striking about the last 20 months is how unwilling bankers, regulators, officials and ministers have been to accept that the free market of the last 30 years is redundant, intellectually and financially. Markets, it turns out, do make mistakes. Public authority does have to shape and reshape the structure in which markets operate. Regulators have to look at system-wide stability rather than assume the market will take care of it.

Above all, the business model of banks is not just a matter for banks. It is a matter of the keenest public interest. Otherwise the bargain – bankers pick up profits while taxpayers pick up losses – is grotesquely unfair.

There were dissidents aplenty. Bob Bennett, the chief operating officer of Northern Rock, tried to rein in the marketing ambitions of its chief executive, Adam Applegarth. The bank was dangerously overdependent on the money markets for its funding. Paul Moore at HBOS tried to restrain the same ambitions of CEO, James Crosby, who used the same business model, but paid with his job. At Standard & Poor’s in the US, Frank Raiter quit early because he felt he simply did not have the information to provide the credit assessments the credit rating agency wanted in the time available.

At the Bank of England, David Blanchflower, a member of the monetary policy committee, says he considered resigning last August because it seemed the only honourable course given the difference between his belief in the coming recession and an inflation report that did not mention the word. Chris Rexworthy, a former director of the Financial Services Authority, freely admits that the regulator did not understand the risks of banks and building societies that grew so reliant on the money markets for their funding. Nor did it try to anticipate the kind of shock that the collapse of US investment bank Lehmans in September 2008 would administer to the British financial system.

But none made any serious difference; the belief in the orthodoxies was very strong. The boom in securitised assets, the unfounded confidence of bankers that they had eliminated risk and the certainties of free market intellectuals were unassailable. And until at least the collapse of Lehmans, the policy response was based on the view that the difficulties were local to particular banks; that no systemic and comprehensive response to the crisis involving Europe, the US and UK was necessary; and that markets would ride out the difficulties with judicious injections of Bank of England cash, whatever the short-term dramas. As one top banker told me, that was the message he received from the governor of the Bank of England on the eve of the collapse of Lehmans. It was a colossal misjudgment.

Thus Northern Rock was not immediately taken into public ownership with its depositors cash guaranteed; we had to go through a bank run and five months of dither before the government finally got to the right decision. And thus in the US the authorities watched for 12 months while a freeze in the American money market first locked investment bank Bear Stearns in a “death spiral” and then mortgage lenders Fannie Mae and Freddie Mac. It could only be a matter of time before other banks were hit at the same time.

The fateful weekend duly arrived on 13 and 14 September last year. The US government found itself simultaneously trying to save the investment banks Merrill Lynch and Lehman Brothers, along with its largest insurance company AIG. Once again, the approach was case by case, but when the Bank of England and FSA saved Barclays from itself by vetoing its planned purchase of Lehmans, the Americans had no plan B. Lehmans went bust, taking the crisis to a new level.

Britain felt the effect immediately, …  http://www.guardian.co.uk/commentisfree/2009/apr/19/banking-budget-recession-will-hutton